The tug of war between better economic news and the potential for rising interest rates could continue to simmer in the background in the week ahead, keeping stocks volatile. Traders will also focus on the whole list of situations that have been unnerving markets, including Europe's economy, Argentina's default, tensions between Russia and Ukraine and the Israeli incursion into Gaza.
The overriding concern, however, had been the idea that the Fed could move to raise rates sooner than expected, fueled in the past week by stronger 4 percent second-quarter GDP growth and the first signs of higher wages and inflation in second-quarter data.
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For now, strategists mostly don't see a deep selloff, even with the Dow's 2.8 percent decline in the past week that erased the its gains for the year. The S&P 500 fell 2.7 percent to 1,925, in its worst weekly performance in two years, and it is now 3.3 percent off the high it set on July 24.
"I wouldn't be surprised if the peak to trough correction in the S&P is around 6 percent. If you go over the last few years and see the type of pullbacks we've had in these situations, 6 percent seems to be a place that has brought cash off the sidelines," said Art Hogan, chief market strategist at Wunderlich Securities.
Stocks sold off sharply Thursday and were also lower Friday, but recovered their worst losses were before the close. The Nasdaq was down 2.2 percent for the week at 4,352, and the Russell 2000 was off 2.6 percent at 1,114.
"There's not much momentum for a sustained selloff. I don't think it will last that long unless there's another catalyst," said Dan Suzuki, senior equity analyst at Bank of America Merrill Lynch.
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Traders will keep their focus on earnings but also economic reports that will either impact GDP or provide more information on potential wage pressures. Stocks wobbled and Treasury yields rose after Thursday's employment cost index showed a jump of 0.7 percent in the second quarter, the fastest pace in six years. Yields at the short end of the curve, which reflect traders bets on Fed funds moves, hit multi-year highs in the past week but gave up gains Friday.
The July jobs report, released Friday morning, showed the economy added 209,000 jobs and that wages were steady. Payrolls were a bit lighter than expected but the report soothed markets in that it was not too hot a number, nor did it show wage pressures.
"From my perspective, where you need to be looking at the end of the week is central bank policy out of Europe, and the unit labor costs out of the U.S. since there is a such focus on wages and labor costs," said Robert Sinche, global strategist at Pierpont Securities.
Productivity and costs are reported Friday morning, and international trade is reported Wednesday. That is a potential swing factor for second-quarter GDP.
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The European Central Bank meets Thursday, as does the Bank of England. Euro zone inflation, reported at 0.4 percent, is at a cycle low and sparked concerns in the past week of deflation. "A lot of times what you see is dovish rhetoric from the ECB and steady as she goes from the Bank of England," Sinche said. "What could be interesting is if you see steady as she goes out of the ECB but actually have more talk of policy snugging out of the Bank of England, talk about raising rates and the things they need to do because the economy performs pretty well."
If the Bank of England is more hawkish, he said that could spill into the market's thinking about the Fed pulling away from its easy policies. The Fed has said it would end the tapering of its bond buying program in October, and economists expect it to begin raising rates in the middle or at least by third quarter of next year.
The ECB is expected to announce further easing efforts later in the year. "If it wasn't August, you might want to look at the ECB meeting, but it's August so I don't think you need to look at the ECB meeting. The inflation numbers there set a new low for the cycle and that probably leads them to think of something new to do for the fourth quarter," Sinche said.
Like other currency strategists, Sinche expects the dollar to strengthen in the second half and finish the year with slight gains against the euro. "We think there's some signs we're getting a little bit of abreakout," he said. The dollar index was up about 0.3 percent for the week, as of late Friday.
Normal Volatility
Suzuki said it would be normal for stocks to continue the selloff and see a 5 percent correction. "That's normal volatility. Investors should be comfortable with that. Over the next months, there's the possibility something could go wrong, whether it's geopolitical or a miscommunication by the Fed. But at this point, we don't see it but that could change," he said. "Five percent pullbacks are quite common. They happen three times a year, but outside of recessionary periods, it's closer to two times. We think investors should take advantage to buy those dips."
Volatility also picked up in the past week with CBOE's volatility index, the VIX, jumping 34 percent for the week. Analysts have been expecting heightened volatility as the Fed gets closer to raising rates, as the markets adjust.
The market has not had a 10 percent or greater correction in two years. "If the market sells off 10 percent or more, history would tell you—unless we're going into a recession, it's almost always a great buying opportunity. iI's very difficult to get that double digit correction in the market without some fundamental shock which we don't see at this point," Suzuki said.
Bank of America Merrill Lynch released its monthly sell side indicator Friday, a monthly reading of the views of Wall Street firms on asset allocation. It has shown an increasingly bearish view of stocks over the past few months. Suzuki said that indicator is a helpful contrarian tool. He said itshows that there is not complacency about the market. The average recommendation of the biggest firms is that investors hold 50.8 percent oftheir portfolio in stocks, down from 51.4 percent in June and below the long-term average of 60 percent.
"If you look at our sentiment gauge it tells you there's an incredible amount of skepticism in this rally. If you look at fund positioning, mutual fund positioning is the most defensive it's been in five years," he said.
Suzuki added that could also be a bullish sign. "I don't think that there's any big fundamental reason for the selloff we've been seeing. Anecdotally, it seems to be driven more by ETF and hedge fund selling, more than the wholesale panic selling or forced selling by investors," he said.
What to Watch:
Monday
Earnings: Marathon Oil, AIG, Vornado Realty, Tenet Healthcare, Cardinal Health, Reaology, Pioneer Natural Resources, HSBC
2:00 p.m. Senior loan officer survey
Tuesday
Earnings: Disney, CVS Caremark, Archer Daniels Midland, MGM Mirage,Michael Kors, Cablevision, Scotts Miracle-Gro, Time Inc., Frontier Communications, Groupon, Potbelly, Take Two Interactive, FireEye, First Solar, Zillow, Liberty Interactive, Liberty Media, Regeneron, Activision Blizzard, Toyota
10:00 a.m. ISM nonmanufacturing
10:00 a.m. Factory orders
Wednesday
Earnings: Time Warner, Mondelez International, Chesapeake Energy, Devon Energy, Viacom, AOL, Molson Coors Brewing, Devon Energy, DishNetworks, Ralph Lauren, Transocean, 21st Century Fox, Keurig GreenMountain, CenturyLink, Jack in the Box, Zulily, ING
8:30 am International trade
Thursday
Earnings: Wendy's, Orbitz, CBS, Monster Beverage, News Corp, Nvidia, Mylan Labs, AMC Networks, Zynga, Lionsgate, Sprouts Farmers Market, Windstream,Duke Energy, Sempra Energy, Stratasys, Teradata, Computer Sciences, GreatPlains Energy
Weekly chain store sales
8:30 a.m. Initial claims
8:30 a.m. Consumer credit
Friday
Earnings: Brookfield Asset Management, Buckeye Partners,Petrobras
8:30 am Productivity and costs
10:00 a.m. Wholesale trade
This article originally appeared in CNBC.
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